September 28, 2020

Tectonic shifts in global supply chains

There is an ongoing process that is shifting supply chains from Asia back to North America, transforming global supply chains into localized supply chains. One of the geographies that is likely to benefit from this peak-globalization process is North America. And the US-China tech and trade war seems to be accelerating this process, as it has already driven some re-shoring of manufacturing processes to North America. The re-shoring process could accelerate even more now that the trade agreement between the US, Mexico (MX) and Canada (USMCA) has been updated. Mexico as a re-shoring destination China’s share in US imports decreased from more than 21% in 2018 to around 17% in 2020. In turn, Mexico’s share of US imports increased from 13% to 14% in the same period (before the pandemic). Mexico’s share could continue to increase due to Mexico’s location, the USMCA trade agreement, low wages, a flexible exchange rate and scale, since Mexico is already a manufacturing and trade powerhouse. Hence Mexico is in an excellent position to increase trade, investment and both actual and potential GDP growth, especially over the next decade. Nonetheless we also see some challenges that Mexico has to overcome to jump-start this opportunity. China vs. Mexico, pros and cons as manufacturing hubs In Exhibit 2 we offer a list of pros and cons for both China and Mexico that support our view that Mexico should continue to gain market share of US imports at the expense of China. Key highlights are: MX offers both resilience and flexibility, as it has guaranteed direct access to US markets; with few or no tariffs (USMCA); large and stable supply chains in multiple industries; with labor costs 26% lower than China’s (Chart 17), the county graduating the world’s fifth-largest number of engineers; transportation costs savings vs. China of +65%; and savings in shipping time of +75%. Moreover, Mexico offers full intellectual property rights protection, a key ongoing concern with China. Mexican stocks: potential beneficiaries of re-shoring

Industrial real estate companies should be beneficiaries of the potential increase of Mexican exports to the US. They have not fully discounted the potential benefits of re-shoring, in our view, in a world with historically low interest rates, paying 2020E and 2021E avg. distribution rates of 7.3% and 8.6%, respectively, and trading at an avg. discount to NAV of 35%. Grupo Mexico Transportes (GMXT) has the largest railroad network in Mexico covering 24 states and controlling more than 66% of rail traffic. GMXT also has a presence in Florida and Texas. GMXT’s 2021E FCFE yield is 7.6%. In our view, Regional is the best positioned Mexican bank to benefit from rising Mexican exports and US economic recovery. Regional’s total commercial loan portfolio in Northern Mexico accounts for 48% of its total commercial loan book.